No. 9242
United States Circuit Court of Appeals
For the Ninth Circuit y
5
Wesr Coast Lire Insurance Company (a cor-
poration), Paciric Nationa Bank oF San
Francisco (a national banking association),
et al.,
Appellants,
VS.
Mercep Irrigation Disrrict,
Appellee.
REPLY BRIEF FOR APPELLANTS.
Cus. L. CHILDERS, PETER TUM SUDEN,
Bank of America Building, 605 Market Street,
KE] Centro, California, San Francisco, California,
Attorney for Appellant, Attorney for Appellants,
West Coast Life Insurance Co. Minnie EB. Rigby as Paecutria
and Riehard tum Suden as Hwx-
Hueu K. McKevirt, ecutor of the Last Will of Wul-
Russ Building, liam A. Lieber, Alias, Deceased.
San Francisco, California,
Attorney for Appellant, David FREIDENRICH,
Pacifie National Bank of San Stock Exchange Building,
Francisco. San Francisco, California,
Attorney for Appellant,
. yd) Pp
Ciark, NicHous & ELTsE, Claire S. Strauss.
t
GEORGE CLARK, TTERMAN PHLEGER,
American Trnst Company Building,
Berkeley, California,
Attorneys for Appellant,
Mary HH. Morris.
Bropeck, PHLEGER & HARRISON,
Crocker Building,
San lranciseo, California,
Attorneys for Appellants,
Cirasr, BARNES & (TASER, Fiorence Moore, et al.
Lucius F. CHASE, W. Conurn Cook,
Title Insurance Building, Berg Building, ae
Los Angeles, California, Turlock, Californiage : j
Attorneys for Appellants, Attorney for Appellants, 4
R. D. Crowell and Belle Crowell. Milo W. Belsins, et al.
PERNAU-WALSH PRINTING COo., SAN FRANCISCO 4
Subject Index
mee tHON. a... tetas ae ee ae ale ee lb oe bse
First Proposition: The Reeonstruction Finanee Corporation
is not a creditor affected by the plan of composition, and
its
ei
IE
GL,
Consent 1s not entitled to be cansidered.............+.
The documents uniformly speak of the transaction
QS 21 CES eee eee ae heen ee a
The RFC and district have repeatedly acknowledged
that the indebtedness of the district to the REC is
thesloan, and not thevold bonds. ........2....0......
The fact that the district, with its own funds, par-
ticipated in payments to bondholders and paid re-
financing expenses further shows there is no obliga-
tion of the district to the Reeonstruction Finance
Corporation on the deposited hbonds................
The setting up of reserve funds for the RFC also
SHOMVGe ie OMn Arran Cement aeee se ad hoo ae eens oe
The RFC is not entitled to be recognized as a ercditor
Pecause tiebacenot flegei claim... ,........0.0 5465:
Thesiransaction resulted in a pledgve................
The REC is fully bound to accept refunding bonds. .
The Reconstruction Finanee Corporation had no au-
thority in law to do other than make a loan to the
district, and the distriet was authorized only to
Ie COMMUN CII aN geet e amr eee aera. al ato che d,4 100.
The plan has been fully executed out of court as to
velba)” Ce Vey aNONS Meera | STEVE UVES = ns Boies eet Fe ee gO
The RFC and the district are bound by the proceed-
He ene Mele MC OLN tes) so gar oane: oheee sc ne eet
No provision in the statute permits debts that have
been extinguished to be treated as still existing......
No rational purpose would be aceomplished by con-
struing the statute as reviving the cancelled
Geiss ior Giriy mon) OSG tec cee rea es =
The provision making public agencies creditors for
‘*full faee value’’ is inapplicable, however con-
ESS
10
li Supgectr InpEx
Page
strued, under the rule against retrospective in-
ferpretation. “o..0.. ).24ceeas eee oe ee 11
12. Appellee’s authorities (in support of its contention
that the REC is a creditor to the full amount of the
old bonds held by it), do not support the contention 13
Second Proposition: Petitioner is barred from obtaining a
confirmation of its proposed plan because of its lack of
good faith and constructive fraud............... eee 17
Petitioner diverted $717,932.50 of trust funds.......... 18
Third Proposition: Petitioner herein is not ‘‘insolvent or
unable to meet its debts as they mature’”’......-) eee 23
Fourth Proposition: The plan of composition is not fair,
equitable or for the best interests of the creditors; and
iS discriminatory < .. <-...4.0. Jb. ee. 23
A. The applicable rules of law concerning what is a
Fail’ lai Cae wise es he oe ae eee 23
(a) Luehrmann v. Drainage Dist. No. 7, 104 Fed.
(20) 696" 0c cos a a 23
(b) Case v. Los Angeles Lumber Products Co., ........
Wee , 00 Sup, Cty 1. oe. 056. eee ee 20
(c) The proposed plan violates the prineiple of the
Boyd ease under any theory of the facts........ 2a
(d) The principle of the Boyd case has two applica-
HONS so2tesnaiee oda se ae 2a
(e) The relation between the petitioner, the land,
the landowners, and the debt...........,..33eee 28
The landowners are the owners of the debtor.. 28
The land is charged with payment of the debt 29
The fundamental principle of the Boyd ease is
the law of California Irrigation Districts... 30
(£) Municipal bankruptcy is a cooperative venture
between the state and federal authorities....... ant
(g) The value of the assessable lands of this peti-
tioner far exceeds the amount of its debts........ 32
B. The facts concerning fairness of the plan........... 33
(a) The issue of fairness is at large: This because
the trial court’s finding is based on irrelevant
facts 2 .kee Wes 33
Supgecr Inprex lil
Page
(b) The question of fairness is independent of the
question how mueh the distriet owes........... 30
(@) Bentioner hasvot shown that its plam is fair.... 35
The Giannini Foundation, or Benedict, Report,
and the testimony of Dr. Benedict at the
former trial, do not show that the district
is now wnable to pay its debts............. 30
The testimony of Mr. Momberg does not show
that the distriet is unable to pay its debts,
butetends to prove the contrary........... 40
There is no evidence in the record that the
RFC refused to lend any more money, as
elaimed by appellee (Appellee’s Br. p. 61).. 41
(d) The aetual net ineome of petitioner during the
last three vears (deducting abnormal power reve-
nue) would service a bond issue of nearly $14,-
HOO000. It otters $8,000,000... 25.64 ....-26 4]
(ec) Merced Irrigation District can, without difficulty,
pay annual bond serviee on a $20,000,000 debt.. 45
The inereased development of the district is
insuranee against reeurrence of past financial
FOO MCI Sp mcr ares ose peeey. «ate Aa eed a, 47
The solution to the problem of uneven power
revenue 1s a fixed maturity bond issue with
flexible sinking fund requirements......... 49
Fifth Proposition: The claims were improperly classified as
periea alone t@aSameG ClISSia: Gieses da eee kG ose eee as 49
Sixth Proposition: The deerce unlawfully takes trust funds
and vested rights belonging to appellants............... ml
On the remaining points we refer to our opening brief..... D1
Table of Authorities Cited
Cases Pages
American Brake Shoe & Foundry Co. v. N. Y. Rys. Co.,
270° Meds 261” 2 ss Gates bes ee ee eee 14
Barry v. Mo. K. & T. Railway Company, 34 Fed. 829...... 15, 14
Burlington City Loan & T. Co. v. Prineeton Lighting Co.,
72 N. J. Eq. 891, 67 Atl. 1019 (Nov. 18, 1907).......... 15
Case v. Los Angeles Lumber Products Company, ............ US
eke , 60 Sup. Ct. 1... ccc ce eee es cu 20, 20) 26) ee ee
Clatlim v. South Carolina R, Co. 8 Fed. 118.7205) eee 13
Continental Ill. Nat. Bank & Tr. Co. v. Chi, R. I. & Pace.
Ry 0.294 U. S.G48 ose. oc ee I
Day & Meyer, Murray & Young, In re, 93 Fed. (2d) 657 28
Fidelity & Columbia Trust Co. v. Louisville Ry. Co., 258
Ky. S17, 81S, W. (20) 8960.4. .5555 eee 14
Fall v. Superior Ceurt, 198 Cal 3i3.......... ee 28
Hassett. vy, Welch, 303 U2 8) 3035.05.0...2 5.2 12
Hershey v. Cole, 130 Cal. App. 683..,.....<......... ee 29
Ketchum vy, Duncan, 96 U.S. 659) 24 L. Ed) cts. ee 15, 16907
Lindsay-Strathmore Irrigation District v. Wutchumna
Water Co., 11) Cal. App. 683... 3255... 29
Luckenback S. 8. Co. v. The Thelka, 266 U. S. 328........ 18
Luehrmann v. Drainage Dist No. 7, 104 Fed. (2d) 696. .23, 24, 25
Metropolitan State Bank v. MeNutt, 73 Colo. 291, 215 Pae.
VO) gece5 Got Stee ee eee ae ee 34
Miller v. United States, 294 U. S. 435.......... eee 12
Missouri K. & T. R. Co. v. Union Trust Co., 156 N. Y. 592,
Bl NE. 309% 2. psa ce eee 17
Moody v. Provident Irrigation Dist., 12 Cal. (2d) 389.... 28
Mowry v. Farmers’ Loan & Tr. Co., 76 Fed. 38.......... 15
provident Land Corp. v. Zumwalt, 12 Cal. (2d) 365...... 28, 30
Saari v. Wells Fargo Express Co., 109 Wash. 415, 186
Pa, “S98 cad ds wots ere a 34
SSS: —
——— ———— cr
TABLE oF AuTHORITIES CITED V
Pages
Union Tr. Co. of N. Y. v. Monticello & Port Jer. R. R. Co.,
oe ONT og SILI, ane oa A ee ie
iniracd siates. v. Carver, 260 U.S, 482 ........200...55.. 23
SeeSiPmiimce Oo ECan 20) ONOs noe incase ses ac se ws os 34
Codes and Statutes
Bankruptey Aet:
CCITT LIS, Cae tS cee ee ee 26
SEAT TTR eee ann oe an 26
SXe COTE (011 Eee ee ei Soe Mina len con2o
SHEE IEUOTT OU) EM ete nS ca a ee 26
BS COM GME OU Od feet tree ea Grn Re srialg aba s ach a8 26
HELO LOD, tS ae ea err es ay 9
OMIM ACD oyad coats eee acs ice 5 he ance reac 66 50
CC UIO MMS 1 NM dear ces eee as oo las) Gola ode tk red 10
PaleconsinmAtt. XX, Section 22; .sc.06aischi seis cea ee ds 5
SN Whos (Cy CCE eee eraie sce rer ta 41
Texts
OL) ANG SILA SRE U1 I aaa ae meer 2 ara ne ee 16
Sal ANG Tig TE AGE eGR are eee ee 6
wecye. Fed Proe., Section 2989, p. 628............2.0.00% 2
Finletter, Principles of Corporate Reorganizations, introdue-
KOT? -CUBU TOPOS, 8 See aera ceo rary career ean ae aa 26
Gerdes on Corporate Reorganization, introductory sections 26
Gerdes on Corporate Reorganization, Vol. 1, p. 95........ 26
Pietarvard | ev. 1093, 1103-4, W0G-7 2.2... 50.4 cece. 14
peetlarvard lohev LOOS1026. ...4 eines. nue oads are cd: 6
cmivemineten on Bankruptcy, p. 233.............2..+-.- 2
3 Williston on Contracts (2d Ed.), Section 781, 5 id.,
FS Cio amt ( aapararm acute Pareles intercity erst eats < sax « 5)
No. 9242
IN THE
United States Circuit Court of Appeals
For the Ninth Circuit
Wesr Coast Lire [Insurance Company (a cor-
poration), Pactric NaTionaL Bank OF SAN
Francisco (a national banking association),
et al.,
Appellants,
VS.
Mercep Irrication District,
Appellee.
REPLY BRIEF FOR APPELLANTS.
INTRODUCTION.
Since appellee has done so, we here repeat, so far as
feasible, the headings in our opening brief, following each
heading with such comment as is called for by the brief
of appellee.
FIRST PROPOSITION: THE RECONSTRUCTION FINANCE COR-
PORATION IS NOT A CREDITOR AFFECTED BY THE PLAN
OF COMPOSITION, AND ITS CONSENT IS NOT ENTITLED
TO BE CONSIDERED.
On this point, appellee first says in its brief (pp. 19,
20):
Italics are ours throughout unless otherwise noted.
2
‘*A. The Court found the Bonds are Owned by the
RFC and are Outstanding. The Issue is Primarily
One of Fact, Not of Law.’’
‘*B. The Evidence Sustains the Finding.’’
Appellee’s discussion suggests that there are questions of
weight and credibility. In fact, there are none. The evi-
dence concerning the relation between RFC and the peti-
tioner 1s all documentary, and all undisputed. See our
brief, pages 10-24. See, also, the brief of Florence Moore,
pages 20-26.
Findings in bankruptey cases are not binding on appeal,
especially where based on documentary evidence, or on in-
ferences from undisputed facts: 6 Cyc. Fed. Proc., See.
2989; p. 628, ff; 8 Remington on Bankruptcy, p. 233.
1. The documents uniformly speak of the transaction as a loan.
Appellee does not dispute the indisputable fact that
throughout the documents constituting the contract be-
tween the RFC and petitioner, the RFC’s advances are
spoken of as a ‘‘loan’’, and the petitioner as the ‘‘bor-
rower’’.
2. The RFC and district have repeatedly acknowledged that the
indebtedness of the district to the RFC is the loan, and not
the old bonds.
The measure of appellee’s answer to this proposition is
furnished by the following quotation from its Brief:
‘“‘In some of the letters or documents written by
employees of the RFC the old bonds are loosely re-
ferred to as ‘collateral’ or ‘security’ and the money
used to buy old bonds as an ‘advance’.
But of course it is of no consequence what phrase-
ology employees or third persons may use in attempt-
ing to describe this rather complicated transaction’’
(Br. Appellee, p. 24).
To the material in our brief (pp. 20-22), we add only the
following: A resolution of the Board of Directors of
petitioner reads in part as follows (R. 377-8) :
‘*Upon motion of Director Wood, seconded by Di-
rector Wolfe, all bills presented were approved and
~~ * warrant No. 35,288 in favor of the Federal
Reserve Bank of San Francisco, being for interest on
money loaned by the Reconstruction Finance Corpo-
ration for the period July 1, 1936 to January 1, 1937,
in the sum of $151,889.71 was ordered paid out of the
refunding bond interest fund.’’
3. The fact that the district, with its own funds, participated in
payments to bondholders and paid refinancing expenses fur-
ther shows there is no obligation of the district to the
Reconstruction Finance Corporation on the deposited bonds.
Appellee’s attempt to meet the proposition stated in the
heading appears at its brief, page 39. In answer, we refer
to the authorities cited in the brief of Florence Moore
(p. 25), which shows the importance of the proposition
stated in the heading.
4. The setting up of reserve funds for the RFC also shows a
loan arrangement.
Nothing need be added to our brief (p. 23). See also the
brief of Florence Moore, pages 24-25.
5. The RFC is not entitled to be recognized as a creditor be-
cause it has not filed a claim.
Appellee treats this point at pages 39-40 of its brief. It
does not meet the simple fact that the RFC filed no claim.
The statute, we submit, forbids taking account of the ac-
eeptance of the plan by any creditor who does not file a
claim.
The point is developed in our brief, pages 24-25. It is
a highly significant fact that the RFC has studiously re-
mained out of this entire proceeding, except for the filing
+
of its consent to the plan. Even its consent is significantly
ambiguous; it does not mention the debt actually owing
to it, namely, the loan; it simply recites that the RFC
‘‘has purchased and now holds bonds aggregating in prin-
cipal amount $14,686,000.’’ This statement is perfectly
consistent with what (we submit) is clearly the real status
of the RFC, namely, that of pledgee.
Pursuant to the statute, on motion of the objecting bond-
holders, the RFC was directed by the Court to appear at a
hearing set to determine whether it is a creditor affected
by the plan (R. 139-140). The RFC did not appear.
6. The transaction resulted in a pledge.
We have shown that under California law (which ex-
pressly governs, R. 216), the transaction was a pledge of
the old bonds and not a purchase thereof by the RFC
(our brief, pp. 25-31; brief of Florence Moore, pp. 23-26).
7. The RFC is fully bound to accept refunding bonds.
The fundamental purpose of the ‘‘Bond Purchase Con-
tract’’ (so entitled) was to provide for the purchase of
bonds, i.e., refunding bonds. Its central provision reads:
‘<* * * the Borrower will issue and sell, and REC will
purchase, not to exceed EIGHT MILLION SIX HUNDRED
THOUSAND ($8,600,000) poLLarRs aggregate principal
amount of the refunding bonds of the Borrower
* % HIP
As we have seen, no word in the contract, nor, indeed,
in the superseded ‘‘agreement’’, makes the obligation of
the RFC to accept refunding bonds conditional upon sur-
render of all the old bonds by the nonconsenting bond-
holders.
We cannot set out the documents in full, but a reading
thereof shows that by the Bond Purchase Contract, the
RFC became bound to purchase refunding bonds in the
maximum amount above-named, and to surrender old
bonds in exchange therefor at 51.501 cents on the dollar.
The appellee quotes (in part) a proviso in this contract,
to the effect that the RFC may, ‘‘in its discretion, keep
any part of’’ the old bonds alive, ‘‘for any purpose”’
(Br. Appellee, p. 23).
Appellee thus says in effect that the parties, by their
ultimate contract, meant one of two things (but does not
clearly say which):
1. ‘‘In consideration of the ‘loan’ of so much, the
‘Borrower’ agrees to pay either the amount borrowed or
approximately twice that amount, as the lender may elect’’,
or
2. ‘‘As between ourselves, the RFC must accept re-
funding bonds in the amount loaned; but as against any
holder of old bonds who refuses to surrender them, the
parties hereto may assert that the full amount of the old
bonds surrendered are an actual debt of the borrower to
the REC.”
Neither of these constructions is tenable, for a number
of reasons:
1. Both would be illegal, and void for the excess over
the actual debt, under the California law, which governs
by express provision (HMxhibit OO, p. 216). See our brief,
pages 25-31, and the brief of Florence Moore, pages 22-26.
2. Both would be grossly usurious, and void for the
excess as a penalty. Cal. Const., Art. XX, Sec. 22; 3
Williston on Contracts (2d Ed.), See. 781; 5 id., Sec. 1407.
3. The second construction would be contrary to the
plain language of the contract. This, because there is not
even a suggestion that the RFC’s alleged option to demand
double payment shall cease if all of the old bonds are
brought in. On the contrary, the RFC’s apparent discre-
tion is absolute. Indeed, the clause says so; it says that
6
if in any way the RFC should ‘‘acquire legal title to all,
or any part’’ of the old bonds, then ‘‘in its diseretion’’ the
REC may keep the old bonds alive ‘‘for any purpose’”’
(Exhibit OO, p. 203).
In other words, if the provision in question is taken to
give the RFC the right, at its election, to demand full
payment of the old bonds, then inescapably the RFC has
that power in any event, i.e., whether all of the old bonds
are surrendered or not. It follows that the second of the
two possible constructions for which appellee contends is
contradicted by the contract itself.
4. But the first possible construction (set out above), is,
in addition to being illegal under California law, simply
fantastic, and contrary to common sense.
It is highly significant, therefore, that an alternate and
entirely reasonable interpretation of the provision is pos-
sible, namely, this:
The parties intended, we submit, to provide by this pro-
vision that the RFC’s security rights in the old bonds shall
include the full mghts of an owner, up to, and as security
for, the amount owing. Although the RFC would probably
have those rights as pledgee without express provision, an
express provision is nevertheless both natural and desir-
able, as is shown by the large amount of litigation that
arises, in cases of partial refinancing, over this precise
question, namely, the question whether one who has made a
loan to a debtor on the security of part of an old bond
issue may assert, as security for the loan the rights of an
outright owner of old bonds. See the many cases on the
question discussed in 47 Harvard Law Review, 1093-1126,
and 81 A. L. R. 139-146.
At page 22 of its brief, appellee says:
‘‘Under this agreement the district agrees to bring
about the participation of all the old securities in the
refinancing plan (Ex. OO, 218).”’
Two comments are appropriate:
1. When examined, the actual provision to which ap-
pellee refers in this statement is simply an undertaking
by the district to attempt to bring about the participation
of noneonsenting bondholders. Actual participation by non-
consenting bondholders ts not made a condition, either in
form or substance. It does not, therefore, change the
pledge to a conditional purchase.
2. The ‘‘Agreement’’ relied upon by appellee was, we
submit, superseded and extinguished long before the first
disbursement, as we now show.
The contractual documents were as follows:
1. The original RFC resolution (Nov. 14, 1934)
GlixeOO, pp. los-79):
2. Acceptance thereof by petitioner (Dee. 11, 1934)
(ix. OO, pp. 180-2) ;
3. An amendment of the RFC resolution (July 6,
Hae OO, jap. 19223).
4. Acceptance thereof by petitioner (July 23, 1935)
(Ex. OO, pp. 194-7) ;
d. An ‘‘Agreement’’ between RIC and the peti-
tioner (Aug. 14, 1935) (Ex. OO, pp. 217-21);
6. The ‘‘Bond Purchase Contract’’ (Sept. 16, 1935)
(Ex. OO, pp. 202-17) ;
7. A second amendment to the original RFC resolu-
tion (about Sept. 17, 1985) (Ex. OO, pp. 193-4) ;
8. Acceptance thereof by petitioner (Sept. 18, 1935)
(Ex. OO, pp. 198-201).
The first disbursement by the RFC was on October 4,
1934, when $14,071,000 of old bonds were surrendered
(R. 344).
8
The ‘‘Bond Purchase Contract’’ of September 16, 1935
(number 6, supra), incorporates by reference the original
resolution of the RFC and the resolution of petitioner ac-
cepting it, 1. e., numbers 1 and 2, supra (Ex. OO, p. 218,
foot). The ‘‘Bond Purchase Contract’’ also provides as
follows (Ex. OO, p. 216):
‘“‘This contract, together with the Resolution of
R.F.C. herein referred to, and also the resolution of
the Borrower, herein referred to, contain the entire
agreement between the parties and shall be governed
by and construed in accordance with the laws of the
State of California.”’
This provision necessarily, we submit, excludes, and super-
sedes, the ‘‘agreement’’ of August 14, 1935 (number 5,
supra), cited several times and quoted at length by ap-
pellee, at pages 22-23, and elsewhere.
Apart from that circumstance, however, as shown above,
the ‘‘agreement’’ does not support appellee’s statement.
Nowhere in the final contract, i.e., the resolutions re-
ferred to and the Bond Purchase Contract, is there so much
as an intimation that all the old bonds must be brought
under the plan as a condition to the RFC’s obligation to
exchange the old bonds held by it for refunding bonds.
We lack space to analyze the contract in detail, and must
ask the Court to read the documents, which are listed above
in order of execution.
8. The Reconstruction Finance Corporation had no authority
in law to do other than make a loan to the district, and the
district was authorized only to accept a loan.
The only argument of appellee that requires notice (pp.
40-41), is the statement that the RFC is by the statute au-
thorized to make loans ‘‘through the purchase of secu-
rities’’. So it is; but one cannot make a loan to a debtor
by purchasing its bonds, unless either (a) the bonds are
purchased directly from the debtor, or (b) the bonds are
(as we say is the ease here), purchased from third parties
for the account of the debtor, and held by the lender simply
as security for the loan.
It follows, as shown in our brief, pages 31-34, that pur-
chase of the old bonds by the RFC on its own account,
would have been ultra vires; and contracts are not con-
strued as so intended.
§. The pian has been fully executed out of Court as to the de-
posited securities.
Nothing in appellee’s brief requires any addition to the
discussion of this point in our brief, pages 35-36.
10. The RFC and the district are bound by the proceeding in the
State Court.
Appellee (pp. 41-2) ignores the plain intent of the Calli-
fornia statute to provide that voluntary acceptance of a
plan is election to make a binding contract, and therefore
is irrevocable in any event, even though the proceeding is
later dismissed, or the statute held void. It follows here
that the debt of appellee to the RFC was fixed as the
amount of its loan, by its voluntary acts in the State pro-
ceeding. This apart from all else in the case.
11. No provision in the statute permits debts that have been
extinguished to be treated as still existing.
Appellee argues that even though its actual debt to the
REC is simply the amount of the loan, secured by the sur-
rendered old bonds, even so (it argues), the statute permits
it to say, as against appellants, that it owes the full amount
of the old bonds. The provisions relied on for this start-
ling proposition are these:
‘‘Any agency of the United States holding securities
acquired pursuant to contract with any petitioner
under this chapter shall be deemed a creditor in the
amount of the full face value thereof’’ (Sec. 82).
10
‘‘The partial completion or execution of any plan of
composition as outlined in any petition filed under the
terms of this Act by the exchange of new evidences of
indebtedness under the plan for evidences of indebted-
ness covered by the plan, whether such partial com-
pletion or execution of such plan of composition oc-
eurred before or after the filing of said petition, shall
not be construed as limiting or prohibiting the effect
of this Act, and the written consent of the holders of
any securities outstanding as the result of any such
partial completion or execution of any plan of composi-
tion shall be included as consenting creditors to such
plan of composition in determining the percentage of
securities affected by such plan of composition’’ (See.
83(j)).
The brief of Florence Moore (pp. 26-32), shows that these
provisions cannot reasonably be construed as appellee con-
tends.
Appellee argues (p. 28) that since Section 83(}) permits
any creditor who has taken refunding bonds to consent, it
should apply here becanse refunding bonds are to be issued
in the future. There are two answers: (a) Section 83(3)
permits consent of the refunding bonds, not of the old
bonds cancelled by the issuance thereof; (b) it follows by
unavoidable implication, that the Congress had no inten-
tion of providing that debts extinguished (as here), by
partial but permanent action out of Court, may be revived
and treated as still existing later on.
No rational purpose would be accom-
plished by construing the statute as
reviving the cancelled debts for any
purpose.
This proposition is discussed in the brief of Florence
Moore, pages 32-34, where it is shown that nothing would
be added to the already ample powers of the RFC to par-
ticipate in refinancing schemes, by the astonishing an-
a
nouncement that the Municipal Bankruptey Act, as quoted
above, has the effect that a petitioner owing $10,000,000
may seale down its debts as if it owed $20,000,000.
It is important to observe that if construed as appellee
contends, the statute would fictitiously swell the claims of
the RFC (and of all governmental agencies), even in cases
where the agency frankly admitted (what the RFC has
never denied in this ease) that it ‘‘held’’ the old securities
merely as pledgee, as security for a much smaller debt.
Moreover, it would have that effect in all proceedings
under the act; not merely as against non-consenting bond-
holders, but as against all other creditors as well. The
outrageous consequences are apparent. Appellee’s con-
struction is therefore opposed by the fundamental canons
of interpretation.
The provision making public agencies
creditors for ‘‘full face value’’ is in-
applicable, however construed, under
the rule against retrospective interpre-
tation.
The proper construction (as above) is, we submit, that
the provisions are intended to settle the much-vexed ques-
tion of the security rights of parties participating in a
partial refinancing.
The RFC is not the United States Government, nor are
its contracts laws. As the Court said in Continental IU.
Nat. bank & Ir. Co. v. Chay, ®. 7. & Pac. Ry. Co., 294
U.S. 648, 684, answering the RFC’s claim to a special posi-
tion in a proceeding under Section 77B:
‘‘The Reconstruction Finance Corporation Act ere-
ates a corporation and vests it with designated powers.
[ts entire stock is subscribed by the government, but it
is nonetheless a corporation, Hmited by its charter
and by the general law. The act does not give it
greater rights as to the enforcement of its ontstand-
ing credits than are enjoyed by other persons or cor-
12
porations in the event of proceedings under the Bank-
Tuptey Act.”
So here, except to the extent that the statute so provides
(and up to the time of any such enactment), the REC’s
rights are simply those of any other creditor lending money
on the security of old bonds.
If the statute were construed as petitioner contends, it
would be giving it completely retrospective effect to apply
it here, 1. e., to say that the debt, which had been owing to
the RFC for two years at the time of the enactment, shall
(as against other creditors), be doubled.
It is settled that every presumption militates against
such a construction, and certainly nothing in the statute
expresses, or even suggests, intent that it shall operate
retrospectively. To our previous discussion (brief of
Florence Moore, pp. 34-36), we add the following:
Hassett v. Welch, 303 U.S. 3038:
A Federal Estate Tax subjected to taxation all ir-
revocable transfers made during decedent’s lifetime, where
he reserved a life interest. The Court here held this in-
applicable to transfers made before the enactment, by one
who died after the enactment. The Court said:
‘‘TIn view of other settled rules of statutory con-
struction, which teach that a law is presumed, in the
absence of clear expression to the contrary, to operate
prospectively; * * * we feel bound to hold that the
Joint Resolution of 1931 and §$803(a) of the Act of
1932 apply only to transfers with reservation of life
income made subsequent to the dates of their adoption
respectively. ’’
Miller v. United States, 294 U.S. 4385:
The Court here held that a regulation of the Veteran’s
Bureau that the loss of one hand and one eye constitutes
total permanent disability, did not applv to a cause of
action existing at the date of the regulation, though the
13
regulation was in foree when action was brought. The
Court said:
‘<The law is well settled that generally a statute can-
not be construed to operate retrospectively unless the
legislative intention to that effect unequivocally ap-
pears. Twenty per Cent. Cases, 20 Wall. 179, 187, 22
L. ed. 339, 341; Chew Heong v. United States, 112 U.S.
Opa 00, co dened ( (0. ((5, 0, Ct, 209; Mullerton-
Krueger Lumber Co. v. Northern P. R. Co., 266 U.S.
435, 437, 69 L. ed. 367, 368, 45 8. Ct. 143. * * * Accord-
ingly, the regulation here involved must be taken to
operate prospectively only.’’
12. Appellee’s authorities (in support of its contention that the
RFC is a creditor to the full amount of the old bonds held
by it), do not support the contention.
Appellee says (pp. 29-87) that in the past,
‘“* * * reorganization agencies found it necessary to
acquire outstanding securities and hold them at their
full face value so as to assure equality among all
holders. <A long line of cases upholds such practice.’’
The fact is, however, that the cases then cited are simply
not in point. They fall into three groups:
1. Several of them announce the rule that a corporation
nay acquire its own bonds and pledge thein as security.
They do not hold, however, or even suggest, that the
holder of sueh bonds is a ereditor to the full amount
thereof. On the contrary, they hold or assume that bonds
so held may be enforced only so far as necessary to pay
the debt for which they are security. Thus, in
Claflin v. South Carolina R. Co., 8 Fed. 118 (cited
and quoted by appellee at page 31),
the Court, said) mowart (p, 133):
‘‘Without pursuing this branch of the case further,
it is sufficient to say that [ am of the opinion that the
holders of all bonds now ont on pledge by the company
are entitled to their proportionate share of the se-
curity of the mortgage, to the extent that may be neces-
14
sary to pay the debts for which they are respectively
held.”’
This case as well as
American Brake Shoe & Foundry Co. v. N. Y. Rys.
Co., 270 Fed. 261, also cited by appellee,
is discussed in an excellent article on the question of cor-
porations pledging their own bonds, in 47 Harvard L. Rev.
1093, 1103-4, 1106-7, quoted below.
Other cases of the same kind cited by appellee are
Fidelity & Columbia Trust Co. v. Lowisville Ry. Co.,
258 Ky. 817, 81S. W. (2d) 896;
Slupsky v. Westinghouse, 78 Fed. (2d) 18.
The article in the Harvard Law Review just referred to
reads in part as follows, and shows that in such cases the
creditor is never allowed to collect more than the actual
debt for which the debtor’s bonds are held as security:
<¢* * * While the giving of one unsecured obligation
of a debtor as collateral security for another unsecured
obligation seems an obvious anomaly, yet in the ab-
sence of any intervening equities of other creditors,
such an arrangement may be of some procedural value,
since some courts may permit the creditor to bring
suit on the collateral rather than on the principal debt.
Although only a single satisfaction not exceeding the
amount of the real debt is allowed in such cases, the
ereditor’s recovery may be expedited if a sealed in-
strument or a negotiable note secures an unfunded
obligation. It is apparent, however, that to permit a
claim to be made in any form of insolvency proceeding
both on the principal debt and on the pledged un-
secured bonds, or on the pledged collateral alone to
an amount exceeding the real debt, will run directly
afoul of the elementary proscription against double or
padded claims. The courts in these cases where addi-
tional unsecured bonds or other evidences of indebted-
ness of the debtor have been pledged as collateral
security have seen clearly the vice in a pledge of a
debtor’s own obligations, and, apparently without ex-
15
ception, have uniformly denied a creditor the right to
prove a claim upon any but the real debt.
If the assets of the corporation are not being ad-
ministered for the benefit of creditors, the pledgee Lof
mortgage bonds], as in the case of unsecured collateral
nay pursue its remedy on the pledged bonds and ob-
tain a personal judgment thereon, subject to satisfac-
tion for only the amount actually owimg. In the event
of insolveney proceedings, however, the only proper
basis for a deficiency claim is the amount owing on the
actual debt. A claim against general assets based
upon the bonds is improper, either in addition to the
claim based upon the actual debt or even as an alterna-
tive thereto.
Where a creditor’s day of reckoning with a corpora-
tion calls for the liquidation of a debt secured by the
corporation’s own mortgage bonds, the unraveling of
the pledgee’s rights is not essentially complicated if
the vital differentiation between the promissory ele-
ment of the bonds and the element of the property hen
is observed. Undoubtedly, of course, the bonds afford
a form of security so far as the proceeds of the mort-
gaged property are applicable. But they cannot serve
to enlarge beyond the amount of actual indebtedness
the basis for the computation of dividends from the
general assets.’’
2. Appellee also cites the following cases on this ques-
tion:
Mowry v. Farmers’ Loan & Tr. Co., 76 Fed. 38;
Barry v. Mo. WNW. & T. Raithvay Company, 34 Fed.
BLO. ata. coe.
Ketchum v. Duncan, 96 U.S. 659, 24 L. Hd. 868;
Slupsky v. Westinghouse, 78 Fed. (2d) 18;
Burlington City Loan & T. Co. v. Princeton Lighting
Con Ne ie. SoG e Ai Olo Now 13, 1907).
In faet, these cases announce and apply a wholly ir-
relevant doctrine, namely this: Where a corporation offers
refunding bonds which are not accepted by all of the old
16
bondholders, and where the old bonds surrendered are not
cancelled, but are held as security for the refunding bonds,
the holders of the refunding bonds may enforce the lien
of the old bonds, on equal terms wtih the non-consenting
old bondholders, so far as and no further than is necessary
to satisfy the amount of the refunding bonds. They hold
simply that the security behind the old bonds accrues to the
benefit of the new bonds.
Three of these five cases are discussed in a note on the
question, entitled ‘‘Lien of mortgage securing corporate
bonds as affected by exchange of bonds for those of re-
organized or new corporations”? (81 A.L.R. 139). None
of these eases even suggests (what appellee contends) that
the amount of the old bonds continues as an obligation of
the debtor. They hold, on the contrary, that the old bonds
survive only as security for the new obligation up to, but
not beyond, the amount of the new obligation.
3. One of the cases cited by appellee,
Ketchum v. Duncan, 96 U.S. 659, 24 L. Kd. 868,
eoncerns still a third situation, not relevant here. In that
ease the claimant had not lent money to the company at
all, whether to buy up securities or for any other purpose.
He had simply bought up conpons on his own account, to
preserve the credit of the company, in which he was
interested. The Court said in part:
‘‘In near prospect of this inability, William B.
Duncan, the head of the firm, on the 28th of April,
1874, telegraphed from New York to the company at
Mobile that his firm would purchase for their own
account sterling coupons, payable in London. The
firm also telegraphed to the Bank of Mobile and to the
Union Bank of London to purchase the coupons there
presented for them, charging their account with the
cost, and transmitting the coupons uncanceled. The
railroad company acceded to the proposition made
Ve
them, and the Bank of Mobile and the Union Bank did
also.’’
The inapplicability of the Ketchum ease here is brought
out strikingly by the fact that the Court approved, but
distinguished a New York case which is in point in the
present controversy, namely,
Union Tr. Co. of N. Y. v. Monticello & Port Jer. R.R.
Con eS NB, Silk
Missouri kK. & T. RB. Co. v. Union Trust Co., 156 N. Y.
992, 51 N. EK. 309, held (concerning an issue of bonds a
small part of which was callable each year by lot) that
the debtor, which had itself acquired most of the bonds,
eould not call the remainder immediately, but was bound
to follow the method for calling bonds provided therein.
Neither the decision nor the opinion has any bearing here.
At the end of this part of its brief, appellee makes the
following statement:
‘¢¥ * * what the Barry case held in effect was that
* * * the dissenting bondholders here are required to
establish their rights on the basis of a $16,000,000 bond
issue.”’
But as just shown, the Barry case does not hold any
such thing; indeed it assumes the exact opposite.
SECOND PROPOSITION: PETITIONER IS BARRED FROM OB-
TAINING A CONFIRMATION OF ITS PROPOSED PLAN BE-
CAUSE OF ITS LACK OF GOOD FAITH AND CONSTRUCTIVE
FRAUD.
Appellee suggests that the requirement of good faith is
(as against appellee) merely a requirement that the plan
be feasible. The numerous authorities under Section 77B
are to the contrary (Our Br. pp. 38-41). The require-
18
ment of good faith appears in substantially the identical
context in Section 77B and in the statute here involved.
When the government or a governmental agency seeks
relief from a Court, it is subject to the same rules as
private litigants.
Luckenback S. S. Co. v. The Thelka, 266 U. S. 328.
Petitioner diverted $717,932.50 of
trust funds.
Appellee says that all the money diverted has been
accounted for. It is no answer to a charge of diversion
of trust funds that the unauthorized uses are shown.
Appellee asserts that sufficient funds are now again in
the treasury of the district to satisfy the claims to di-
verted trust funds (p. 45). The diversion by appellee
of the trust funds, the intent that such diversion shall be
permanent, and the effect of hindering, delaying and de-
frauding creditors, are clear from the undisputed evidence
(Our Br. p. 45).
Appellee asserts that all the money collected and not
spent for necessary ‘‘operations’’ is now in the treasury
to be placed where the Court orders (Br. p. 45). This is
not true. There was spent by the district, during the
period 1933 to 1987, inclusive, for capital betterments,
alone, $321,601.52;* in capital payments (R. 515), on
Crocker-Huffman contracts for the purchase of water
rights, $299,049.34 (R. 847, 853, 864, 874, 882); irrigation
district bond principal, $59,000**; principal payments on
drainage bonds, $61,200 (R. 848, 854, 865, 874, 883); re-
financing expenses (exclusive of interest paid depositing
bondholders), $284,430.82 (R. 847, 854, 865, 875, 882).
*1933, $32,692.42 (R. 847); 1934, $40,933.48 (R. 853); 1935, $52,392.34
(R. 864); 1936, $80,187.85 (R. 874); 1937, $115,395.43 (R. 882).
**1933, $24,500 (R. 84S); 1934, $34,500 (R. $54).
19
A total of $966,281.68 was thus spent for capital and re-
financing expense, which was not operating expense.
Appellee clainns that ‘‘each year from 1922/23 to
1931/32, inclusive, after bond service was satisfied, the bal-
ances of the bond fund levy (delinquency collections, ete.)’’,
were placed in the general fund as expressly authorized
by law, and that such transfers occurring prior to 1933
@ccount tor “all but $320,272.93” of the $717,932.50 (App.
Br. 45). Appellee thus claims that this money was legally
transferred from the bond fund before 1933 when the
bonds were not in default.
This is not true. The undisputed testimony of Mr.
Neel, auditor for the district, is that the entire amount of
$717,932.50 was collected ‘‘as a result of the collections
of delinquent taxes that were delinquent as of December
31, 1932"" (R. 414). Thus, the entire amount was collected
after December 31, 1932, and after the bonds of the dis-
trict were in default, so that the right to transfer had
ceased.
Appellee adinits the diversion of $320,272.93 of 1932/33
collections (App. Br. p. 45), but gives as its excuse that
under the first refunding plan of 1933, which never went
into effect, it was proposed that this money be transferred
for general purposes of the district. It is no excuse for
diversion of trust funds to say that the district would
have been entitled to the money if an agreement had
been made.
Appellee repeatedly states that the granting of the
REC loan raised the price of the bonds from 18 cents to
50 cents (p. 48). This statement is not defensible. The
testimony of Mr. Lester (R. 500) referred to in appel-
lant’s brief was that the bonds sold at 18 at the bottom
of the depression, but had reached 32 in the fall of 1934,
and it was undisputed that there was a bid of 56 for the
20
bonds February 5, 1935 (R. 521), eight months before the
first disbursement under the RFC loan, in October of
1935 (R. 367). The bonds of overlapping tax lien dis-
tricts, which have no greater security than have the irri-
gation district bonds, and which were not ‘‘refinanced’’
by the RFC, and upon which principal and interest has
been paid (R. 419, 540), such as Merced Union High
School District, have recovered with securities generally,
so that they are now selling above par (R. 889). The
effect of the RFC loan has been to limit the price of the
bonds to 50. The passing of the panic, and the inherent
value in the district would have raised the price well
above that figure.
Appellee (p. 48) claims that refusing to levy taxes for
six years for bond purposes was pursuant to law. Even
Section 11 of the District Securities Act under which the
taxes were levied (Our Br., Appendix), requires the levy
of a tax calculated to produce a delinquency of 15%. The
actual delinquency produced as of the delinquent date for
the year 1937-38 was $23,528.48, or 6.84% as of the last
Monday in June, and as of November 1, four months later,
was reduced to $12,262.39 (R. 668). Delinquency after
one year in each of the levies from 1933 to 1937 as of
November 1, 1938, average 114%. Therefore (App. Br.
pp. 46, 47), petitioner has not, we submit, complied with
the law under which such reduced taxes were levied.
The district misrepresented its financial condition.
The primary basis of our discussion of this point was
appellee’s own balance sheet (1x. 26).
The term ‘‘balance sheet’’ is defined in The New Mer-
riam-Webster Dictionary as ‘‘A statement of the financial
condition of an individual or organization at a given date,
esp. a statement of assets, liabilities and net worth’’. This
is the only meaning given to the term, either in the dic-
21
tionary, or in the works on accounting. The testimony of
the district’s auditor at the trial was that this exluibit
purported to be a true statement of the financial condi-
tion of the district, assuming that its indebtedness in-
eluded the whole bond account (R. 425).
Appellee (App. Br. p. 50) states that “petitioner did not
overstate its labilities’’. In support of this statement,
while it cannot avoid the undisputed fact that $824,684.00
paid to RFC as interest, and other interest paid or not
due, was still kept as a liability of the district on its
balanee sheet, appellee attempts to excuse itself by the
claim that this interest was carried on the books as an
‘‘interest expense account im the nature of a refinancing
charge’’.
This is no justification, and further, is not true. Mr.
Neel testified that this amount was ‘‘paid on bond interest
expense’’ or as ‘‘an interest expense account”’ (R. 425). It
is shown in the published financial statements of the dis-
trict for 19386 and 1937 (R. 875, 885) as ‘‘Interest Account,
Reconstruction Finance Corporation’’. As we have shown,
the district charged the same tmterest twice. It paid it
once out of its cash account, as an operating expense, and
set it up the second time as a fictitious liability, although
it had already been paid. No amount of adroit general
statement can avoid the fact.
It is true as to the overstatement in bond principal, that
all parties knew the indebtedness was $16,191,000. How-
ever, a separate item of $387,000 additional was set up in
a different place as a current lability, where it was not
readily perceivable, and, as stated in Mr. Lombard’s afh-
davit, that amount was charged to surplus. In short, a
fictitious deficit was created by the charge. Since the
question at issue was as to whether the district had a
surplus or deficit, and how much, and the direct effect of
this maneuver was a fictitious mcrease of the deficit, there
22
ean be no question as to the material falsity of the state-
ment in this respect.
Petitioner contends that it did not understate its assets.
It claims that if the assessment levy of $340,000 should be
included as an asset, estimated expenditures of 1939 should
be ineluded in the balance sheet as a liability. The very
definition of the term ‘‘balance sheet’’ in the dictionary
discloses the fallacy of this statement. .A balance sheet
contains only assets, liabilities and net worth as of a given
date. Jé is not a budget wherein future expenditures and
income are included. The $340,000 was a current, collee-
tible, account receivable, secured by a lien on all of the
lands in the district, and constituted an asset. Kstimated
expenditures for the future did not constitute a lability.
Appellee half admits (App. Br. p. 52) as its secretary
did in fact admit (R. 515), that the Crocker-Huffman con-
tracts constituted a capital asset which were not shown as
assets but were charged off to operating expense.
Appellee denies that it kept books and records on two
separate theories of its liabilities to the RFC. It made
reports and balance sheets to the RFC showing liabilities
of $13,000,000 less than the liabilities set forth in Exhibit
26, a balance sheet (ix. J & K, R. 774, 784). Those bal-
ance sheets were approved by the RFC, and the district
eonfirmed the REC auditors’ statements as to the amount
of the liability to the RFC shown on the district records
(Ex. N, R. 797), writing to the RFC ‘‘the above is m
agreement with our records at December 31, 1936, with
the following exceptions * * *.** The evidence remains
undisputed that the district kept one set of records and
a balance sheet for the RFC, and it introduced in Court
another balance sheet and set of records, in which its
liabilities were set up as $13,000,000 greater (App. Br.
p. 06).
EU ee
23
THIRD PROPOSITION: PETITIONER HEREIN IS NOT ‘‘IN-
SOLVENT OR UNABLE TO MEET ITS DEBTS AS THEY
MATURBE’’.
See the discussion of this point in our brief (pp. 53-4).
Appellee says (p. 0+) that even though appellee owes the
REC only $7,570,000, as we contend, then ‘‘presumably”’,
‘the KR.F.C. at any time can demand payment of the
entire sum * * *”’
This is not true. The RFC’s rights are stated in the
documents, and the right to demand full payment at any
time is not among them.
FOURTH PROPOSITION: THE PLAN OF COMPOSITION IS NOT
FAIR, EQUITABLE OR FOR THE BEST INTERESTS OF THE
CREDITORS; AND IS DISCRIMINATORY.
We first deal with the law concerning what is a fair
plan, with particular reference to Case v. Los Angeles
Lumber Products Co., supra.
A. THE APPLICABLE RULES OF LAW CONCERNING WHAT IS A
FAIR PLAN.
Preliminarily we deal with appellee’s discussion of this
and another case.
(a) Luehrmann v. Drainage Dist. No. 7,
104 Fed. (2d) 696.
The appellee relies extensively on the Luehrmann case
just cited in the heading. We therefore discuss the case
rather fully.
1. Appellee says (p. 54) that the denial of certiorari
in this case is ‘‘highly significant’’. <A sufficient answer is
the following quotation from
United States v. Carver, 260 U. S. 482, 490:
‘‘The denial of a writ of certiorari imparts no ex-
pression of opinion upon the merits of the case, as
the bar has been told many times.’’
24
2. Appellee repeatedly (pp. 19, 29, 37) refers to the
Luehrmann case as authority for its contention that the
RFC is a creditor to the full amount of the old bonds.
The fact is that in the Luehrmann case it was not even
contended that the RFC was a creditor beyond the amount
of its loan, it being conceded by all concerned that the
RFC’s right in the old bonds was simply that of a pledgee.
There are three opinions: One by the District Court
passing on the constitutionality of the second bankruptcy
statute (21 Fed. Supp. 798), the District Court’s opinion
approving the plan (25 Fed. Supp. 372), and the opinion
of the Circuit Court of Appeals (104 Fed. (2d) 696). In
its first opinion the District Court said,
‘*In this particular case, however, no agency of the
government holds the old securities, but they are in
fact held by a trustee who appears to have taken
over legal title from the original bondholders, the
larger portion of whom transferred the bonds to the
trustee through the agency of the Bondholders’ Pro-
tective Committee’’ (21 Fed. Supp. 801, 802).
The terms of the trust spoken of by the Court do not
appear, but it does appear unequivocally that the trustee,
and not the RFC, was owner of the bonds.
The trial Court, in approving the plan, made a finding
reading in part as follows:
‘¢* * * said bonds are held now as collateral to the
note of Louis V. Ritter, Trustee, and are voted in
favor of the debt readjustment plan * * *”’ (104 Fed.
(2d) 702).
The Circuit Court of Appeals said on this question:
‘<* * * Chapman, holding as trustee 98.2% of such
bonds, filed acceptance of the plan * * *.
‘¢ “the old outstanding bonds, as well as the judg-
ments purchased from the Cross County claimants
are being held by the Federal Reserve Bank in Cleve-
25
land, as collateral to the trustee notes.’ (Given for
the proposed loan and advancements by the Recon-
struction Finance Corporation)’’ (104 Fed. (2d) 699,
700).
3. In the Luehrmann case both the trial Court and the
Cireuit Court of Appeals relied on the fact that a large
proportion of the bondholders had consented, as being
evidence of fairness (25 Fed. Supp. 378, 104 Fed. (2d)
703). This, indeed, is coneeded by appellee (App. Br. pp.
64-5).
4. Appellee states, at page 91 of its brief:
‘‘The issue of res judicata also was apparently in-
volved in Luehrmann v. Drainage Dist No. 7, 104
Fed. (2d) 696, and resolved against appellants. ”’
There is no foundation for this statement. It nowhere
appears that the issue of res judicata was in the case;
and indeed it could not have been, for the reason that
although a proceeding was brought by the district under
the first Municipal Bankruptcy Act, that proceeding was
dismissed by the petitioner district, after the decision of
the Ashton case (21 F. Supp. at p. 822).
5. In the Luehrmann case it is explicitly held that the
District there involved (an Arkansas Drainage District)
was not a governmental agency (see 104 F. (2d) at p. 698).
(b) Case v. Los Angeles Lumber Products Co.,
me Uso, OU sup. Ct, 1.
The obvious importance of the case cited in the heading
makes it unnecessary for us to analyze the Court’s opin-
ion, since the Court has undoubtedly examined that opin-
ion itself.
The appellee seeks to escape from the Los Angeles
Lumber Products Co. case by arguing that Section 77B
is a reorganization statute and the Municipal Bankruptcy
26
section a composition statute, and that therefore under
the latter section the plan need not be found ‘‘fair and
equitable’? within the settled meaning of those words,
established long before they were used in this statute
(App. Br. pp. 54-59).
This argument need not detain us long. As is well
known, the earlier devices for dealing with insolvent
enterprises (without compelling dissolution) were (a) the
old composition Section 12 of the Bankruptey Act, and
(b) the procedure developed by the Courts without the
aid of statute in equity receivership proceedings. Neither
was entirely satisfactory, and the Congress undertook to
provide adequate statutory procedure: It enacted Section
77 (for railroads), Section 77B (for private corporations),
the first Municipal Bankruptcy provision (Section 80), and
thereafter the present provision (Sections 81-84). All are
developments from, and combine qualities of, the old com-
position sections and the judicially developed equity re-
ceivership; all are substantially identical in their essential
requirements. As stated by Gerdes on Corporate Re-
organization, Vol. 1, p. 95:
‘*Section 77B merely applies the principles of com-
position, modified to meet the problems peculiar to
enterprises corporately owned.”’
See the introductory sections in Gerdes on Corporate Re-
orgamezation, and in I’inletter, Principles of Corporate Re-
organizations.
The words ‘‘fair and equitable’’ appear in the same con-
text in Sections 77, 77B, the first municipal bankruptey
provision, and the section here involved. The Los Angeles
Lumber Products Co. case says that they are words of art
with a fixed legal meaning. The opinion points out ex-
plicitly that the ‘‘fair and equitable’’ standard was not
present in, or required by, the old composition section 12.
27
(c) The proposed plan violates the
principle of the Boyd case under
any theory of the facts.
The principle now established by
Case v. Los Angeles Lumber Products Company,
eee US OUND Cat.
is summarized in the following quotation by the Court from
an earlier opinion:
‘‘Tn Louisville Trust Co. v. Louisville, New Albany
& Chicago Ry. Co., supra, this Court reaffirmed the
‘familiar rule’ that ‘the stockholder’s interest in the
property is subordinate to the rights of creditors.
First, of secured, and then of unsecured, creditors.’
And it went on to say that ‘any arrangement of the
parties by which the subordinate rights and interests
of the stockholders are attempted to be secured at the
expense of the prior rights of either class of creditors
comes within judicial denunciation.’ ”’
This doctrine, we submit, is no mere rule of thumb. On
the contrary it is a simple and obvious principle of com-
mon honesty.
It is not to be assumed that the Court will be less
solicitous to preserve this principle in administering the
municipal bankruptey sections than it is in administering
the corporate reorganization sections.
(d) The principle of the Boyd case
has two applications.
There are two applications of the principle that a plan
is unfair where its effect is that the subordinate rights of
the debtor, or the equitable owners of the debtor, are
secured at the expense of the prior rights of creditors:
1. Where the property responsible for the debts is
worth less than the amount of the debts, then the creditors
must be given the full value of the property chargeable
with the debts; for if they are not, the plan simply takes
28
property which belongs to the creditor and gives it to the
debtor. The Los Angeles Products case holds that this is
unfair.
2. Where the assets exceed the amount of the debts,
then, for the same reason, no plan is fair whereby the
creditor is compelled to take less than the amount of his
claim. This necessarily follows from the same principle.
Thus, in the case of
In re Day & Meyer, Murray & Young, 93 Fed. (2d)
697,
the Court said, in part:
‘‘Where the value of the mortgaged property is
more than the principal amount of the bond indebted-
ness, there is no justification in reducing the indebt-
edness to one-half of the principal.’’
* * * * * * *
‘It is the duty of the court to scrutinize the plans
of reorganization proposed for insolvent companies
to make certain that the assets belonging to creditors
are not by indirection diverted to stockholders. In re
New York Rys. Corp., 2 Cir. 82 F. 2d 739; Inene
Barclay Mark Compe supra:
(e) The relation between the petitioner,
the land, the landowners, and the
debt.
The landowners are the owners
of the debtor.
Although the landowners in an irrigation district are
not shareholders, they are in substantially the same posi-
tion as shareholders, being the equitable owners of the
debtor. Thus, in Hall v. Superior Court, 198 Cal. 373, it
was held that certain Judges, who were the owners of land
in an irrigation district, were disqualified in an action
against a private water company for damages caused by
seepage of water from a eanal, where the irrigation dis-
trict had a proprietary interest in the canal. The Court
said in part:
29
“While not occupying the precise status of stock-
holders in a corporation, yet the land owners, as
members of an irrigation district, sustamm such a
relation to the district as to give them a proprietary
interest in the district’s property. This relation is
aptly pointed out in the case of Merchants’ Nat. Bank
v. Escondido Irr. Dist., 144 Cal. 329, 334 (77 Pac. 937,
cane se
‘““TThe statute vests in the landowners] a definite
proportion of the water of the district, and in all, in
common, the equitable ownership of its water-rights,
reservoirs, ditches, and property generally, as the
means of supplying water. (Stats. 1887, pp. 34, 35,
sees. 11, 18.) Such rights as these cannot be distin-
guished in any way from other private rights, * * *’’.
See, also:
Hershey v. Cole, 130 Cal. App. 683;
Inindsay-Strathmore Irrigation District v. Wutch-
umna Water Co., 111 Cal. App. 688.
The land is charged with payment
of the debt.
Any number of cases make it clear that these bonds are
in practical effect the equivalent of (and indeed superior
to), a mortgaging of the lands of the district as security
for their payment. Thus, in
Provident Land Corp. v. Zumwalt, 12 Cal. (2d) 365,
373-4,
the Court said of irrigation district bonds,
‘‘In our opinion, the statute was intended to secure
the bonds by the proceeds of the land in the district.
It is true that the bonds themselves are not a lien on
the land. But the assessment is a lien (sec. 40), and
the district is required to collect the assessment or
sell the land.’’
Again, in
Moody v. Provident Irrigation Dist., 12 Cal. (2d)
389,
30
the Court quoted and relied on an earher case concerning
municipal bonds, to the effect that they are ‘‘equivalent
to a trust deed’’.
fhe fundamental principle of the Boyd
case is the law of California Irrigation
Districts.
There is no doubt that the law controlling California
irrigation districts includes, in essence, the very principle
of the Boyd case. Thus, in
Provident Land Corp. v. Zumwalt, supra,
the Court said (12 Call (2d) 370, Sie 31253 /5-ohe
‘‘The ordinary method of payment of bondholders
is clearly indicated by these provisions. The direc-
tors must levy assessments in a sufficient amount to
meet principal and interest payments.’’
The Court then referred to the depression of the early
’30s, and said:
‘‘As a result, some districts now own practically all
the land within their boundaries, * * * The delin-
quencies have gone too far in this and other districts
to save the landowners. * * * In our opinion, the stat-
ute was intended to secure the bonds by the proceeds
of the land in the district. It is true that the bonds
themselves are not a hen on the land. But the
assessment is a lien (sec. 40), and the district is re-
quired to collect the assessment or sell the land. * * *
Evading creditors is not a contemplated activity
of a public district, whose bonds are recognized in-
vestments for financial institutions. Among other
purposes of the act, therefore, is the repayment of
the bondholders of the district, and it follows that
this is one of the purposes for which the trust money
is held.
This view is fortified by a consideration of the
general plan of the statute, in so far as it provides
for the creation of an obligation and a procedure for
payment. The land is the ultimate and only source of
payment of the bonds. * * * Any practice which re-
31
moves the land from its position as ultimate security
for the bonds, or which places its proceeds beyond the
reach of the bondholders, destroys that plan and is
contrary to the spirit of the act.’’
The foregoing discussion demonstrates, we submit, that in
every essential respect the situation created by the issu-
ance of irrigation district bonds is precisely that con-
templated by the principle of the Boyd case.
(f) Municipal bankruptcy is a co-
operative venture between the
State and Federal authorities.
It is important to observe that the second Municipal
Bankruptey Act requires cooperative action by both the
Federal Government and the States. As stated at
numerous points in the Municipal] Bankruptcy Act, the
Federal Courts in administering the Act must be careful
not to encroach in any way upon the sovereign powers of
the states; and under the Bekins decision this is not
merely a statutory requirement but a constitutional re-
quirement. The cooperative nature of municipal bank-
ruptcy is referred to three times in the Court’s opinion
(304 U.S. 27, 53-4).
Obviously, the State’s part of the enterprise includes
provision of means for compliance with the principles of
the federal statute, including the principle of the Boyd
case.
Tt cannot be said that the State, or an agency of the
State, can confront the Federal Courts with a plan which
violates principles of bankruptcy, and insist upon its
approval.
32
(g) The value of the assessable lands
of this petitioner far exceed the
amount of its debts.
As shown at length in our opening brief, the conservative
value of the privately owned lands in the district (at least
$50,000,000), 1s two and one-half times the total amount
of the district’s debts, even assuming that its whole bond
issue is still owing (Our Brief, pp. 64-66). Appellee does
not dispute this.
These figures ignore the property owned by the district
itseli, and ignore the fact (also shown in our opening
brief), that the district’s power revenues alone will amor-
tize and extinguish nearly half of the district’s total debts,
even on its own theory. It follows that in actual fact, the
conservative value of the privately owned lands in the
district is from four to five times the amount of debts
which they must be looked to to pay, even assuming, with
appellee, that the whole bond issue is still owing (our
brief, pp. 66-71).
The situation confronting this Court may, therefore, be
summarized as follows:
This petitioner borrowed $16,190,000 and issued bonds
therefor. Largely with the bondholders’ money it acquired
assets, the present value ot which, as shown by its own
records, exceeds $20,000,000 (our brief, p. 64). As security
for the moneys borrowed, its contract with the bondholders
encumbered the lands of the district, consisting of 189,000
acres, the present value olf which (largely attributable to
the bondholders’ money) exceeds $50,000,000.
In these circumstances, then, with corporate assets of
over $20,000,000, with lands chargeable for its debts worth
at least $50,000,000, with power revenue sufficient to amor-
tize and discharge nearly half of its total debt on its own
theory, the petitioner now tells the Court that it should
be permitted to repudiate half the principal amount of its
EEE —_ —_
33
debt, and the whole (as to appellants) of six years of
delinquent interest.
A more striking violation of the rule of common honesty
laid down by the Supreme Court could hardly be imagined.
B. THE FACTS CONCERNING FAIRNESS OF THE PLAN.
The first point is this: that in legal effect there is no
finding that the plan is fair.
(a) The issue of fairness is at large:
This because the trial Court’s
finding is based on Irrelevant
Facts.
The trial Court found, simply in the language of the
statute :
‘‘That the plan of composition as offered by the
petitioner herein is fair, equitable and for the best
interests of its creditors * * *’’ (R. 214).
But the Court’s opinion discloses that this finding is based
in large part on the proposition that the major propor-
tion of creditors consented to the plan. The opinion below
reads in part:
‘We consider as most forceful, irrefutable evidence
of the fairness of the plan the indisputable fact that
more than 90 per cent. of the invested capital in the
bonds of the District has taken advantage of it. The
legal requirement of debt composition under Chapter
IX of the Bankruptcy Act has been exceeded by nearly
25 per cent. of the affected invested capital.’’
As the Court said in Case v. Los Angeles Lumber Prod-
WEES CO). csnmsnnn | Wier Ress ee 00 See ele:
‘*Hence, in this case the fact that 92.81% in amount
of the bonds, 99.75% of the Class A stock, and 90%
of the Class B stock have approved the plan is as im-
material on the basic issue of its fairness as is the
34
fact that petitioners own only $18,500 face amount
of a large bond issue.’’
See the trial Court’s entire discussion of this point, Rec-
ord, pages 175-6.
It is settled that such a finding will not sustain a decree;
on appeal, the Court either orders a new trial or itself ex-
amines the evidence, makes a finding one way or the other,
and affirms or reverses accordingly. Thus, in the case of
In re Welsh, 5 F. (2d) 918,
it was held that although both the Referee in Bankruptcy
and the District Court had concurred in a finding, it would
not be accepted on appeal because it appeared that the
Referee and the Court below took account of evidence
which should not have been considered on the question.
See, also, for example, Saari v. Wells Fargo Express
Co., 109 Wash. 415, 186 Pace. 898, where the Court said:
‘‘In cases tried by the court, we ordinarily consider
that improper and incompetent evidence is given no
prejudicial weight or credence, but here the contrary
affirmatively appears. The report of Benjamin to
the police department was improperly admitted, and
was given undue weight and improper analysis by the
triak court. ?
Metropolitan State Bank v. McNutt, 73 Colo. 291,
eile) deca lai:
‘‘The general rule that it is presumed that the
court considered only competent evidence cannot be
applied here, because it is shown by the bill of ex-
ceptions that the court rested its conclusions on evi-
dence which is not competent on the issue in ques-
tion.”’
In the present ease, therefore, the trial Court’s finding
eannot stand; and the question whether the plan is or is
not fair is at large. We have shown at length that it is
not, and supplement that discussion below.
30
(b) The question of fairness is inde-
pendent of the question how much
the District owes.
Obviously the question whether the proposed plan is
fair is wholly independent of the question how much the
District owes. Much of appellee’s argument resolves itself
into the argument in substance that (a) Appellee needs
relief; (b) Therefore the plan is fair.
(c) Petitioner has not shown that its
plan is fair.
We now discuss the important items of evidence put
forward in appellee’s brief to support its contention that
the plan is fair.
The Giannini Foundation, or Benedict,
Report, and the testimony of Dr. Bene-
dict at the former trial, do not show that
the district is now unable to pay its
debts.
Appellee’s brief contains numerous statements to the
effect that the Benedict, or Giannini Foundation, Report,
shows that the petitioner district is so insolvent as to
require the adoption of the petitioner’s plan of composi-
tion (Br. Appellee pp. 6, 61). There is no justification
for this statement. The report was originally the basis
for the first refunding plan, wherein the district agreed
in 1933 to refund the indebtedness of the district for the
principal amount of $16,191,000 in 50 year sinking fund
bonds, with interest at 4% and 4.4% (Ex. OO, pp. 90, 91).
That such a plan was justified we may agree, but that the
report gives any basis for the repudiation of the major
portion of the district’s indebtedness proposed in the
current plan is not true.
The Giannini Foundation Report (Ex. 35) and the
testimony of Dr. Benedict at the former trial (R. 432-471
36
incl.) relate only to the 3 year period 1929-31 (Ex. 35,
p. 23) (R. 435) (not, except as to a supplemental study of
26 admittedly non-typical large corporate operations
(Ex. 35, pp. 19, 64), for six years, as appellee states
(Br. Appellee p. 5). This was a panic period admittedly
not typical (R. 451), the end of which was nearly 7 years
prior to the trial of the case below.
The report therefore is of little value on the question
of present ability to pay.
In the meantime there have been many substantial
changes. Testifying in April of 1936, at the former trial,
Dr. Benedict stated ‘‘it is true, I think, that costs are be-
ing somewhat reduced from what they were in the period
when this survey was made’”’ (R. 471). The agricultural
price index stood at 87 in 1931, 70 in 1933, and 121 in
1937 (Br. Appellee, App. A), showing a marked rise in
agricultural prices at the same time that costs were
dropping, so that the net result of operations, which Dr.
Benedict considers the essential question (R. 456) was
very much better at the time of the trial than it was in
1s
The Giannini Foundation Report was prepared on the
assumption that the $4,500,000 in mortgages (Ex. 35,
p. 109) ought not to be sealed down in any reorganization
(R. 458-459). It was also prepared upon the assumption
that the debt should be such as could be carried by the
large land owners (R. 470). These include large corporate
enterprises for colonization of the land, as well as corpo-
rations operating foreclosed lands (Ex. 35, p. 64), such as
California Lands, Inc., a Trans-America subsidiary (R.
473).
The report is not a study of the ability of the district
as a whole to pay taxes, or of the average within the
district, but only of certain of the poorer lands. Of the
total assessment levied for the year 1930-31 ($1,194,-
Oo”
585.35), there was first eliminated from consideration in
the survey the city lands, having an assessment of
$132,219.85, and rural properties of less than 20 acres,
and land not sampled, of $605,619.99, or a total of
$740,924.39, or 61% of the assessed value. There was
included in the studies only samples from properties hav-
ing an assessed value of $456,745.51 (xv. 35, p. 103), or
39% of the total assessed value.
That the samples studied were from the poorer situa-
tions in the district is demonstrated by a comparison of
the total tax delinquency for the entire district in 1931,
of 17.63% (Ex. 35, p. 103), totaling $210,596.89 (R. 667)
with the delinquencies of $199,731.32, or 43.73% for the
lands sampled in the survey. This leaves $10,865.57 or
1.4% as the delinquency, of the property not mcluded in
the survey, having an assessed value of $740,924.39, as
against a delinquency of 48.73% for the lands included
in the survey (x. 35, p. 103), having an assessed value
of $456,745.51.
While the record does not disclose which of the prop-
erties sampled, including 1638 farms over 20 acres in
size, were the ones substantially delinquent, it does appear
that delinquencies were very much heavier for the large
corporate properties (R. 470), and that individuals operat-
ing family size farms are much more efficient than large
corporate and individual operators (Ex. 35, p. 64). These
facts, coupled with the low (1.4%) delinquency on the
farms under 20 acres, suggest that the major delinquency
was in 39 large holdings comprising 64,000 acres (R.
681) in the district, including Trans-America holdings of
6000 acres (R. 473), and that the owner-operated farms
were earning sufficient to pay their taxes, even in the
depths of the depression.
The farms covered by the report are limited to 150
farms out of 2800 in the district, being the middle 50%
38
of 300 farms selected by lot out of 1600 farms in the
district (R. 470) (Ex. 35, p. 23) (R. 467). In these 150
cases, investigators went to the farmers and in ‘‘one
sitting’’ (Ix. 35, p. 23) elicited such information as they
could, based on the farmer’s remembrance of his trans-
actions during the preceding 3 year period (Ex. 35, p.
24). It is admitted in the report that the records thus
secured will be ‘‘subject to some little error’’, and that
‘‘the incentives for biased replies are greater in the
present case than in ordinary farm management studies”’
(Ex. 35, p. 24).
The results achieved in the study of deciduous fruits,
for example (R. 485, pp. 32 to 37), indicating a very
large variation in results and a rather low profit or loss,
are in marked contrast to results obtained by the Uni-
versity of California in one of the same years by care-
fully kept records of the operation of peach orchards in
Stanislaus County, where, in the year 1929, the University
of California study, based on accurate records, shows a
per acre net profit of $467.50 (Kix. 35, App. H, p. 95, and
Table 9 of App. H, p. 102).
It is apparent on the face of some of the tables that
cost allowances for family labor are, in many eases, fic-
titious, and create the illusion of a loss on operations,
where, m fact, a profit was made. While space does not
permit us to point out the numerous examples of such
obvious fictitious family labor charges, we call attention,
as an example, to Schedule No. 244 in Table 29 (Ex. 35,
p. 51), showing a net loss of $42.40 per acre. Table 27
(Ex. 35, p. 49) shows that on this same ranch (Schedule
244) there was a total labor charge of $105 per acre, of
which $7.50 was hired, and $97.50 was family labor. There
are a number of farms shown in Table 27 where all of the
labor was hired, but the most paid on any farm where ail
of the labor was hired was $39.51 (Schedule 320, Table
39
27, Ex. 35, p. 51). It is a fair inference that the family
labor has been over-valued by $65, in Schedule 244. Re-
ducing the cost charged on Schedule 244 by the $65 per
aere overcharge, shows a profit of $23 per acre instead
of the loss of $42.40 per acre. An examination reveals
similar discrepancies throughout all of the tables; and
we believe it is a fair statement to say that the elimina-
tion of fictitious labor charges for family labor alone
results in showing a rather substantial profit on the
average, for the farms studied in the Giannini Founda-
tion Report.
The Court will also note that in Tables 8, 9, 10, 14, 19,
16, 21, 19, 22, 25, 27, 28, 32, 33, 34, 38, 39, 40 and 43 of
the Giannini Foundation Report (Ex. 35), showing costs
of operation of specific farms, the higest cost per acre
ranges from 10 to 40 times the lowest cost per acre for
the same type of crops, on the same type of. lands, on
farms of similar acreage. This variation alone is so con-
trary to the probabilities as to suggest that the study
cannot be relied upon.
The report contains studies of large corporate organ-
izations during the period 1926-27-28, showing, as Dr.
Benedict put it, ‘‘rather heavy losses” in those years, when
they operated directly (R. 438). That these operations are
not typical is demonstrated by the fact that when the
same lands were rented to individual operators, they re-
ceived a small net return, even in those years of panic
conditions (R. 439). The report admits they were not
typical (Ex. 35, p. 64, p. 19): The owners, being banks
and colonization conipanies, were essentially speculators,
not operators (Ex. 35, p. 64).
Nowhere in the Giannini Foundation Report, or in
the testimony of Dr. Benedict, is the opinion expressed
as to what amount the district could and can pay, even as
of that time. As above stated, the report was originally the
40
basis for a refunding plan for payment of the entire prin-
cipal amount of the indebtedness (Ix. OO, p. 90).
The testimony of Mr. Momberg does not
show that the district is unable to pay its
debts, but tends to prove the contrary.
Appellee states (Appellee Br. p. 6) that the testimony
of Mr. Momberg shows the same situation that Dr. Bene-
dict had found, and that the lands of the district are not
now operating at a profit (Appellee Br. p. 61). Both of
these statements are unsound. Mr. Momberg testified only
concerning lands taken over on foreclosure by the Bank of
America and affiliates. Dr. Benedict testified (R. 438),
and the Giannini report showed (Ex. 35, p. 64) that this
type of corporate enterprise was much less efficient than
the owner operated farms comprising the bulk of the dis-
trict, and were losing (R. 438) in the period 1929-31. The
operation of California Lands, Incorporated, was there-
fore not a typical operation but a bad one. However,
contrary to the statement in appellee’s brief, the testimony
of Mr. Momberg was to the effect that California Lands,
Incorporated, was making a profit—not losing money in
the period from 1935-388 (R. 488, 489). Mr. Momberg did
not testify as to his opinion of the fairness of the plan
or as to the results of operation of the average farm. He
did testify that the lands which he managed were average
for the district (R. 49), that 67 sales had been made (R.
489), that the average sales price for the property which
the company now holds is $135 per acre (R. 485), that
although properties were operated at a loss in 1932 (R.
481), the net result of operating all properties in the years
1935-38, inclusive, showed a profit (R. 488, 489), that aver-
age operating expenses were $27 per acre, that the
$3 per hundred tax rate amounted to $1.75 per acre, and
that this represented only 5% or 6% of the operating cost
of the farms (R. 494).
:
41
There is no evidence in the record that
the RFC refused to lend any more money,
as claimed by appellee (Appellee’s Br.
p. 61).
Since the district did not place m evidence any of the
appraisals or even the application for the loan made to
the RFC, the inference is that the appraisal was favorable
to a greater loan. Presumably the RFC followed the stat-
ute (48 U. 8. C. 403) which says that before making a
loan the RFC must be satisfied that the borrower will be
able to get in ‘‘a major portion’’ of its bonds at ‘‘the
average market price of such bonds over the six months
period ending March 1, 1933’’, i. e., at panic prices.
The amount of the RFC loan is therefore no evidence
concerning the ability of the district to pay.
Appellee’s statement (p. 61), that ‘‘The R.I.C. con-
eluded the District could not carry a greater loan than
the plan provides for’’ is therefore (to put it mildly),
unsupported by the record.
(d) The actual net income of peti-
tioner during the last three years
(deducting abnormal power reve-
nue) would service a bond issue of
nearly $14,000,000. It offers $8,-
500,000.
As noted above, the value of the lands in the district
is conservatively two and one-half times the amount of its
debts, which are a first charge upon those lands. We now
discuss the income-produeing capacity of the district, 1. e.,
its ability to pay its debts without recourse to the security.
We stated in our opening brief that, despite the facet
that the petitioner district has levied an extremely low
tax of $1.75 (R. 490) or $1.80 (R. 517) per aere, entitling
the landowners to + acre feet per annum per acre, the
cash on hand in the district treasury increased from $346,-
313.61 on December 31, 1934 (R. 852) to $1,578,446.14 on
42
November 1, 1938, a gain of $1,232,132.53 in three years
and ten months. In answer thereto, in several] places in
appellee’s brief (pp. 62, 71), appellee has stated that this
was entirely due to a ‘‘providential’’ power yield. An
analysis of the income and expenditures of the district
proves that this is not true.
Since the data for 1938 is not complete, we shall con-
sider the years 1935, 1936 and 1937. The actual power
revenue and total revenue received by the district in those
three years was:
Power Total
Year Revenue Revenue References
SES $ 551,047.22 S03 1020.07 (R. 863)
1936 584,429.64 1,194,075.78 (R. 873)
1937 602,008.94 1,137,342.72 (R. 881)
$1,737,485.80 $3,368,443.57
The undisputed evidence, from the studies made for ap-
pellee by Thebot, Starr & Anderton, Inc., Consulting Elec-
trical Engineers (Ex. OO, p. 105), the reports made to
the RFC by appellee district (Ex. OO, p. 105, and R. 783),
report of appellee to the District Securities Commission
for 1936 (R. 729), and the testimony of appellants’ wit-
nesses Heinz (R. 894) and Louis C. Hill (R. 534) is that
the average annual income from power revenue for the
district is $500,000 or more. The excess power revenue
over the normal amount of $1,500,000 for the three-year
period 1935 to 1937, inclusive, was, therefore, only $237,-
485.80. Subtracting the amount of power revenue in excess
of normal ($237,485.80) from the actual revenue received
by the district during the three years ($3,368,443.57),
gives us normal gross revenue for the district, after elimi-
nating the above normal power revenue, of $3,130,957.77.
During this period, the actual expenses for maintenance,
operation, general overhead and capital betterments was
as follows:
43
Maintennnee, Total Normal
Operntion kixpense and
Capital and General Capital
Year Betterments Overhead Betterments Reference
1935 $ 52,392.34 $276,550.25 $ 328,942.59 (R. 864/5)
1936 80,187.85 318,102.70 398,290.55 (R. 873/5, inc.)
1937 115,395.43 360,784.73 476,180.16 (R. 881/3)
Total $247.975.62 $955,437.68 $1,203,413.30
Total annual average expense and betterments $401,134.43}
There would thus be available for bond service in a
three-year period of average power revenue, the difference
between the corrected normal gross revenue of $3,130,-
957.777, based on actual tax collections, rentals, ete., and
normal power revenue, and the actual expenses of $1,203,-
413.30, or a total normal net revenne for the three-year
period of $1,927,544.47.2 This amounts to $642,514.62 per
annum net income or surplus available for bond service.
1. This compares with average annual expense for capital betterments
and maintenance. operation and overhead (exeluding Crocker-Huffman eon-
tracts) for the two vear period 1931-32, of $287,605 (calculated from data
at R. 693).
2. Collections from delinquent taxes during the period in question, being
were probably about $100,000 per annum in excess of normal. To maintain
tax collections at the same rate as collections for 1935-37, therefore, the tax
rate would be increased m future years hy enough to raise this $100,000,
which, on the basis of $320,000 collections, from a rate of $1.75 per aere
(R. 490. 667) would require an increased levy of about 55¢ additional per
acre, making the future rate, to maintain these tax collections, about $2.30
per acre.
3. This balance of the revenue for the three-year period 1935-37
($1,927,544.47) would all normally be available m future for debt service.
It ts accounted for as follows:
Increase cash on hand from December 31, 1934 ($346,313.61,
R. 852) to December 31, 1937 ($1,136,498.01, R. 880)....... $8 790,184.40
Crocker-Huffman contract payments (capital expenditures which
iammimecenmuly 1. Lett (Cex OO. p. Usd)... 26. ae ne kes 201,932.81
Principal of drainage bonds (capital expenditures, last maturity,
Pomeblom ls Ex OOM pats). ese se. 6 nee eee wens 31,800.00
Non-recurring items, i. e@, Refinancing expense exclusive of
interest paid depositing bondholders, 1935-37..............-. 213,403.65
poss son moinle Dcpositia.g 1.0.2 sess cos ens eee ee men «tee 6 74,724.47
{Interest paid R. F. C. and depositing bondholders............. _ 843,259.06
Interest paid on drainage bonds and on old Irrigation District
[OTIS = oc Sa eeeee ere S oare ou na meen Oe to caer eee eee 9,724.78
‘Soran dla, TR, GYOSSS), Giic) OD. CiSvIEN) Rie occa cg oc 0 a cleieen $2.165,029.17
Less power revenue in excess of normal, as calculated above... 237,485.80
$1,927 ,543.37
Hlsey aly Ube TI@ Clemens tener uaa ot tts ate ale cece ls gasses) sats seals sie ¥4)4 1.10
AVA ABIU Se hOR BOND SERVICE... 2. c.e.e ee iss $1,927 544.47
44
This normal average annual net income ($642,514.62) as
sufficient to pay principal and interest on a 50-year bond
wssue (such as was proposed im the first plan), bearing
interest at 4%, of over $13,800,000.4
The district’s proposed plan provides for a 4%, 33-year
issue of $8,250,000 to retire district bonds ($350,000 addi-
tional to retire Crocker-Huffman contracts will not be used
(R. 511)). The actual experience of the three-year period
1935-37, adjusted to eluminate excess of power revenues
over normal, with maintenance, operations and capital ex-
pense considerably higher than previously (R. 693), dem-
onstrates conclusively that the district can without any
difficulty pay $5,500,000 more than is proposed in its plan,
without mcereasing its collections from taxes.
Thus the actual experience of the appellee during the
last three full years demonstrates the grossly unfair na-
ture of its plan. It operated during those three years
under an assessment rate so absurdly low as to produce
a rate of delinquency after one year of only 144%, which
is plainly less than the normal rate of delinquency in the
best of taxing districts in normal times. But notwithstand-
ing that fact, the mcome of the district (ignoring abnor-
4, TABLE OF ANNUAL AMOUNT NECESSARY TO RETIRE BOND
ISSUE OVER 50-YEAR PERIOD, WHEN PRINCIPAL
AND INTEREST ARE PAID SEMI-ANNUALLY:
Interest $20,000,000 $15,000,000 $10,000,000
Rate Bond Issue Bond Issue Bond Issue
3% $ 774,831.00 $581,123.00 $387,415.00
4% 928,108.00 696,081.00 464,054.00
5% 1,092,475.00 $19,356.00 546,238.00
TABLE OF ANNUAL AMOUNT NECESSARY TO RETIRE BOND
ISSUE OVER 30-YEAR PERIOD, WHEN PRINCIPAL
AND INTEREST ARE PAID SEMI-ANNUALLY:
Interest $20,000,000 $15,000,000 $10,000,000
Rate Bond Issue Bond Issue Bond Issue
3% $1,013,736.00 $760,802.00 $506,868.00
4% 1,150,720.00 852,040.00 575,360.00
5% 1,294,136.00 970,602.00 647,068.00
45
mal power revenues), was sufficient to service a debt, set
up precisely as in its plan, many millions of dollars greater
than it offers to pay.
(e) Merced Irrigation District can,
without difficulty, pay annual bond
service on a $20,000,000 debt.
The average annual power income of the district is
$500,000 (Ix. OO, p. 105; R. 783, 729, S94, 534). Average
annual collections from land rentals, water tolls, normal
colleetions of delinquent taxes (excluding annual extraor-
dinary collections of about $100,000), interest, and miseel-
laneous revenue, as shown during the period 1935-37 (R.
863, 873, S81), exclusive of current taxes, are about $120,-
000. The total norinal annual revenue other than current
taxes is, thus, $620,000. Average annual expenses, for
capital betterments, maintenance and operation, and over-
head, based on actual expenditures during the period
1935-37, are $400,000 per annum (supra). The annual in-
come available for debt service, before the levy of current
taxes is, therefore, $220,000.
We can caleulate the amount which can be produced by
a levy on the land on the basis of experience. During the
past three vears, when, according to the testimony of Mr.
Sargent, the average assessed value of an acre of land
was $60, and the tax rate was $5 per hundred, the levy
was $1.80 per acre, or according to Mr. Momberg, who
testified that he managed average lands in the district,
$1.75 per acre (R. 490). Exhibit 25 (R. 667) shows that
collections for the vear 1937-38, to the last Monday in
June of 1938, were $320,516.17 (R. 667). It is a simple
calculation to determine that if a rate of $1.75 per acre
will produce $320,000, a levy of $1 per acre will produce
$183,000, a levy of $2 per acre will produce $366,000, a
levy of $3 per acre will produce $548,000, a levy of $4
per acre will produce $731,000, a levy of $5 per acre
46
will produce $915,000, and a levy of $6 per acre will pro-
duce $1,100,000. In order to ascertain the amount avail-
able for bond retirement, it is only necessary to add to
these sums the $220,000 net revenue left from other income
of the district after paying its current expenses and
capital betterments. Adding the $220,000 thus available, it
appears that a levy of:
$1.00 per acre will produce annually for bond service $403,000.00,
2 00 (a3 (a9 é¢ é¢ oe éeé ce e¢ 586,000.00,
3.00 ee a4 éé éé 6 ce éé cé 768,000.00,
4.00 €¢ 6 (a4 éé éé éé é oe 951,000.00,
500 ee se wa ee 1,185,000
6:00; 7 eg Us ee pee «ee 1 320,000%mm
A reference to the table in the footnote (supra) shows
what amounts of bond issue at the interest rates shown
can be retired by these payments. A $6 per acre rate
will retire $20,000,000 in bonds bearing 5% interest over
a thirty year period. A $35 per acre rate will retire a
$20,000,000, 5% bond issue over a fifty year period, and a
$4 per acre rate will retire a 4%, $20,000,000 bond issue
over a fifty year period. Since the improvements paid
for by the bond issue will far outlast a fifty vear period
from today, and the district once approved such an issue
(Ex. OO, p. 90), we think an issue of that maturity proper.
This brings us to the question as to what a proper rate
per acre would be.
Reference to the record in the case of Palo Verde Irri-
gation District now before the Court will disclose that in
that district the average acre of land actually pays from
$5.50 to $6 per acre in irrigation district charges (Jordan,
et al. v. Palo Verde Irrigation District, Case No. 9133,
U. 8. C. C. A., 9th Cir., BR. pp. 288, 321, 322) 312
record in that case discloses that that district has a much
higher percentage of unimproved alkali and worthless land
than has the Merced Irrigation District. It also will show
47
that that district is limited in its productivity to alfalfa,
cotton, cattle and grains (Palo Verde Ree. p. 314). The
record in this case shows intensive cultivation in Merced
District. Sixty-one per cent of the total assessed value in
the Mereed Irrigation District is contained in the cities
within the district, and in 1100 farms of under 20 acres
each (Hx. 35, p. 103). A large area in Merced District
is planted to various types of fruit trees and vineyards.
The rest of the land is suitable, for the most part, for
the crops raised in the Palo Verde Irrigation District
(Ex. 35). Costs are higher in the Palo Verde Irrigation
District for farming and for transportation, because of its
distance from market (Palo Verde R. p. 314). Merced
Irrigation District is very fortunately situated geograph-
ically.
Water costs, even for field crops, ranging up to $20
an acre, in places in Southern California and in the lower
San Joaquin Valley, are matters of common knowledge
(Ex. OO, p. 145).
If Palo Verde Irrigation District can pay $6 per aere,
certainly Merced Irrigation District, with its superior ad-
vantages, can also do so. But if Merced pays only $6 per
acre, it can pay all of its normal costs of betterments,
maintenance, operation and overhead, and still service and
retire a $20,000,000, 5% bond issue in thirty years.
The increased development of the district
is insurance against recurrence of past
financial problems.
Appellee did, as it claims, unquestionably have serious
fmancial problems during the years prior to 1934. Prob-
ably the greatest problem arose from the fact that the
period, just as the district was getting started, and while
it was still being colonized, turned out to be the driest
period in the recorded history of the area. This had the
48
two-fold effect of reducing power revenue substantially
for that limited period, and somewhat impairing water
supply for irrigation purposes. The period was also the
period of the most serious agricultural and business panie
in the history of the United States.
But in the three-year period, 19385 to 1937, inclusive,
there was a $237,000 excess of power revenue, and in 1938
an excess of over $200,000 of power revenue. At the same
time, the index of agricultural prices rose from a low in
1932 of 65 to a high in 1937 of 121 (App. Br. Appendix),
while even in April, 1936, Dr. Benedict noted a decrease
in agricultural costs. The enormous increase in efficiency
of farm machinery during the past five-year period, and
the tremendous saving of cost as a result, are matters of
common knowledge.
As of the date of the trial, the selling price of the repre-
sentative lands (R. 492) held by California Lands, Inc.,
averaged $135 per acre (R. 485), sixty-seven sales had
been made (R. 489), and nearly all sales were made on
installments (R. 489), so that the payments which had
to be earned from the land must average between $15 and
$20 per annum, principal and interest, depending on the
length of time the purchase contracts ran.
There is a tremendous demand for agricultural lands
at a reasonable price. The report of the Governor’s Com-
mission on Reemployment of the State of California, made
September 30, 1939, says (p. 28), ‘‘The most casual survey
reveals that thousands of farmers with farm experience
are unable to buy or rent land. At the same time, large
scale farming is more prevalent in California than in any
other state’’.
Thirty-nine owners in Merced Irrigation District hold
over one-third of the land in the district (R. 681). A very
49
small percentage of the area of land in the district (1100
farms under 20 acres and the cities) sustains 61% of the
assessed value of the district. With the tremendous de-
mand which exists for small farms, and the large amount
of land available for subdivision in the district, it is rea-
sonable to expect a great increase in the intensification of
agriculture within the district. With continued develop-
ment and stabilitv, many of the problems of the past will
be, or have been, solved.
The solution to the problem of uneven
power revenue is a fixed maturity bond
issue with flexible sinking fund reqnire-
ments.
The remaining problem of variation of power revenue
was considered in the refunding plan of 1933, and was
very satisfactorily solved in that plan (ix. OO, p. 91). The
arrangement in that plan was that all of the bonds should
have a fixed 50-year maturity, that part of the bonds
should bear 4% interest and part of the bonds 4.1% in-
terest, and that the district should set up a sinking fund
to purchase bonds in accordance with its revenue. Thus,
in periods of subnormal power revenue it would retire
an excess amount of bonds and less, or none, when power
revenues were low.
This is the answer to the lean and fat cycles in the
revenue of the district, rather than the unnecessary repu-
diation of bonds, proposed in the district’s current plan.
FIFTH PROPOSITION: THE CLAIMS WERE IMPROPERLY
CLASSIFIED AS BEING ALL OF THE SAME CLASS.
See our brief (pp. 74-76), and brief of Florence Moore
(pp. 26-32). One point there emphasized is this:
00
By Section 83(b) of the Bankruptcy Act:
‘“‘The holders of claims for the payment of which
specific property or revenues are pledged, or which
are otherwise given preference as provided by law,
shall accordingly constitute a separate class or classes
of creditors.’
By the contract between petitioner and RFC, the peti-
tioner pledged the revenues to be received from power,
‘‘in each calendar year commencing January 1, 1936
except the first $100,000 thereof and except any amount
in excess of $575,000 in each such calendar year
HK #99
The petitioner agreed that,
‘‘such allocation shall be irrevocable’’ (R. 209, 210).
Thus, in the language of the statute, RFC is ‘‘the holder
of a claim for the payment of which specific property or
revenues are pledged’’.
This one point, we respectfully submit, concludes the
case.
Appellee’s only attempt to meet it is the following
statement:
‘‘If refinancing is never consummated and the R.F.C.
does not take the refunding bonds obviously the set up
of the reserve funds and the allocation of the power
is nullified.”’
This is nonsense. In the first place we have shown that
the contract now existing between the RFC and appellee
is an unconditional loan. Moreover, there is no shadow
of a basis for contending that the RFC’s exaction of this
security is conditional upon getting in all the old bonds.
ol
SIXTH PROPOSITION: THE DECREE UNLAWFULLY TAKES
TRUST FUNDS AND VESTED RIGHTS BELONGING TO
APPELLANTS.
Appellee hegs the question. It savs the very object of
the bankrupteyv laws ‘‘is the equitable distribution of the
debtor’s assets among his creditors’’ (Br. Appellee, p. 81).
As a general principle of bankruptcy law, it is of course
true that the purpose is an equitable distribution of unen-
cumbered assets among general creditors. But bankruptcy
has never gone to the lengths of taking property belonging
to a creditor and giving it to the debtor. Appellee fails
entirely to meet the proposition that the bondholders are
not merely creditors. They are the equitable owners of
the assets of the district.
The proposition here is that the actual equitable owner-
ship of the bondholders is taken from them—not merely
that their contracts are impaired. Bankruptcy may impair
a contract but it may not confiscate property, and that is
what appellee seeks to do here (see Our Brief p. 77). We
refer also to the discussion in brief of appellants in the
case of Moody et al. v. James Irr, Dist., No. 9353, now
before this Court, particularly pages 74-89.
ON THE REMAINING POINTS WE REFER TO OUR
OPENING BRIEF.
Lack of space prevents reply to appellee’s treatment of
the remaining points in our opening brief. We therefore
refer on these matters to our opening brief, except as to
our Ninth Proposition, which is that it is res judicata
between the parties that the Constitution forbids the grant-
ing of the relief sought. The separate reply brief of Mary
o2
Morris, filed herein by Mr. George Clark, replies fully W
appellee’s discussion of this point.
Dated, San Francisco, California,
December 26, 1939.
Respectfully submitted,
Cuas. L. CHILDERs,
Attorney for Appellant,
West Coast Life Insurance Co.
Huau K. McKevirt,
Attorney for Appellant,
Pacific National Bank of San Francisco.
Ciark, NicHors & ELtss,
GEORGE CLARK,
Attorneys for Appellant,
Mary E. Morris.
CuHass, Barnes & CHasz,
Lucius F.. CHAsg,
Attorneys for Appellants,
R. D. Crowell and Belle Crowell.
PETER TUM SUDEN,
Attorney for Appellants,
Mumnie EL. Rigby as Executrix and Richard
tum Suden as Executor of the Last Will
of William A. Lieber, Alias, Deceased.
Davip FREIDENRICH,
Attorney for Appellant,
Claire S. Strauss.
HERMAN PHLEGER,
Broseck, PHurcer & Harrison,
Attorneys for Appellants,
Florence Moore; American Trust Company as
trustee under a certain agreement between
R. S. Moore and American Trust Company
dated December 15, 1927; Crocker First Na-
tonal Bank, as trustee under a certain agree-
ment between Florence Moore and Crocker
First Federal Trust Company, dated Decem-
ber 15, 1937.
4)
W. Copurn Cook,
Attorney for Appellants,
Milo W. Bekins and Reed J. Bekins as trustees
appointed by the Will of Martin Bekins, de-
ceased; Milo W. Bekins and Reed J. Bekins
as trustees appointed by the Will of Kather-
ine Bekins, deceased; Reed J. Bekins; Cooley
Butler; Chas. D. Bates; Lucretia B. Bates;
Edna Bicknell Bagg; Nancy Bagg Eastman;
Charles C. Bagg; Horace B. Cates; Barker T.
Cates; Mary Kdna Cates Rose; Mildred C.
Stephens; N. O. Bowman; W. H. Heller;
Fannie M. Dole; James Irvine; J. C. Titus;
Sam J. Eva; William F. Booth Jr.; George N.
, Keyston; George W. Pracy; H. T. Harper,
) and George B. Miller as trustees of Cogswell
Polytechnical College; Tulocay Cemetery
Assocution, a corporation; Percy Griffin;
Emogene Cowles Griffin; D. Lyle Ghirardelli;
A, M. Kidd; Grayson Dutton; Frances N.
Shanahan; Stephen H. Chapman; Edith O.
Evans; J. Ofelth; Dante Muscio; I. M. Green;
E. J. Greenhood; Julia Sunderland; LInly
Sunderland; Florence S. Ray; Joseph 8S. Ray;
Amelia Kingsbaker; S. Lachman Company, a
corporation; Sue Lachman; Sophia Mae-
kenzie; Nettie Mackenzie; R. J. McMullen; J.
R. Mason; Gilbert Moody; William Payne;
C. H. Pearsall; Alice B. Stein; Sherman
Stevens; IE. G. Soule; Margaret B. Thomas;
Isabella Gillett and Effie Gillett Newton as
executrices of the Estate of J. N. Gillett, de-
ceased; Theo. F. Theime; Fletcher G. Flah-
erty; Frances V. Wheeler; Afiriam H. Parker;
Apphia Vance Morgan; First National Bank
of Pomona; George F. Covell; Alma H.
Moore; George Habencht; Seth R. Talcott;
Adolph Aspeqrez; J. WH. lame: Mas. J. H.
Fine; F.G.G. Harper; and W.S. Jewell.
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